How to calculate Total Addressable Market (TAM) - Startups 101

Summary

This video discusses the common pitfalls startups face when calculating their Total Addressable Market (TAM). Steve Barse, a managing partner at Dream Adventures, emphasizes the importance of a bottom-up approach over the flawed top-down method. He highlights the need to accurately identify target customers and pricing, and to avoid using the size of the problem or the entire market as a proxy for TAM. Barse provides real-world examples to illustrate the correct way to calculate TAM, stressing the importance of documenting assumptions and using precise figures to avoid unrealistic market size estimations.

Takeaways

• 📝 TAM (Total Addressable Market) is the total market demand for a product or service, encompassing all potential revenue.
• 📉 Avoid top-down TAM calculations; they are often unrealistic. Use a bottom-up approach instead.
• ⚠️ Common mistakes include confusing the size of the problem with the TAM and using competitors' pricing without adjusting for your own pricing.
• 🔢 TAM calculation should be based on the number of target customers multiplied by your accurate price.
• 🌍 Clearly define the geographical regions when calculating the number of target customers.
• 💵 Ensure your pricing is accurate and based on tested and validated assumptions, not just competitors' prices.
• 📊 Document and show your work in TAM calculations, including assumptions and sources of data.
• 🔍 Narrow down your target market to specific segments to get a realistic TAM.
• 🎯 Investors often look for a minimum billion-dollar market to ensure sufficient room for growth and profitability.
• 🔄 The TAM calculation model works across various industries, including B2B, B2C, e-commerce, and social networks.

Q & A

What is TAM and how is it defined?

TAM, or Total Addressable Market, is the total market demand for a product or service, representing all revenue opportunities available.

Why should startups avoid a top-down approach when estimating TAM?

Startups should avoid a top-down approach because it often leads to unrealistic estimations by assuming a small percentage of a large market. Instead, a bottom-up approach, which documents assumptions and shows how the TAM comes together, is recommended.

What is the main mistake health tech companies make when calculating TAM?

Health tech companies often mistake the size of the problem (e.g., the opioid crisis) for their TAM. The size of the problem does not equate to the market size for their specific product or service.

What is a more accurate method for calculating TAM?

An accurate method for calculating TAM involves multiplying the number of target customers by the price of the product or service, ensuring both figures are realistic and well-documented.

How should a startup document their assumptions when presenting TAM calculations?

Startups should document their assumptions by providing footnotes on their slides, detailing where the number of customers and pricing data come from. This transparency helps validate the TAM calculation.

What factors should be considered when determining the number of target customers?

Factors include the specific market (e.g., US, Europe, global), the customer profile (e.g., small banks without a chief information security officer), and the geographical regions targeted.

Why is accurate pricing crucial in TAM calculations?

Accurate pricing is crucial because using incorrect pricing can significantly skew the TAM. Pricing should be based on tested and validated data, not assumptions or competitor prices.

What example illustrates a common mistake startups make with pricing in TAM calculations?

An example is a startup using a competitor's price of $5,000 per customer per month when they plan to charge only $500. This results in a TAM that is ten times larger than it should be.

What does the term 'narrowing of the TAM funnel' refer to?

Narrowing the TAM funnel refers to starting with a broad market size and refining it by focusing on specific target customers, geographical regions, and realistic pricing to determine the actual market size.

What minimum market size do venture capital investors typically look for in a startup's TAM?

Venture capital investors typically look for a minimum market size of one billion dollars. This ensures that the market is large enough to support substantial growth and returns on investment.